Broken Windows and the Ghost of Keynes

For every dollar of Microsoft revenue from Windows Vista in 2007 in the U.S., the ecosystem beyond Microsoft will reap $18 in revenues. In 2007 this ecosystem should sell about $70 billion in products and services revolving around Windows Vista.

The IDC research shows that the launch of Windows Vista will precipitate cascading economic benefits, from increased employment in the region to a stronger economic base for those 200,000 or so local firms that will be selling and servicing products that run on Windows Vista. Nearly two million IT professionals and industry employees will be working with Windows Vista in 2007.

These direct benefits —157,000 new jobs and $70 billion in revenues to companies in the US IT Industry — will help local economies grow, improve the labor force, and support the formation of new companies. The indirect benefits of using newer software will help boost productivity, increase competitiveness, and support local innovation.

In the history of economic thought, this is Multiplier Effect, the belief that an increase in spending leads itself to more spending and even more spending, in a feedback loop that in the end amounts grows the entire economy. This bootstrap theory was popularized by John Maynard Keynes and became influential in some circles as a way to reduce underutilization in the economy. In other words, if unemployment is high and industrial capacity is underused, then it is worth while to have the government make work for people or spend money. Work, any work, will get the money flowing again. This lead to the various “alphabet agencies” of F.D.R.’s New Deal program.

Keynes, at his boldest, illustrated the magical properties of his multiplier effect like this:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course by tendering for leases of the note-bearing territory), there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

— from The General Theory of Employment, Interest and Money

The most cogent criticism of the Magic Multiplier goes back 50-years to Henry Hazlitt’s, Economics in One Easy Lesson, where he tells the tale of “The fallacy of the broken window”. It goes something like this:

Imagine the town baker’s shop window is broken by an errant baseball throw. A unfortunate expense to the baker, one might say. But that is a narrow parochial view. Look instead at the benefit to the whole community. The window will cost $300 to replace. That money will go to the glazier who will then use his profits to buy a new sofa from the furniture store, who will then use his profits to buy a new bicycle for his child from the toy store, and so on. The money will continue to circulate in over-widening circles, bringing joy to all. The original loss of $300 by the baker will more than be made up for by the aggregate increase in the amount of goods and services exchanged in the town. Instead of punishing the little boy who broke the window, he should be raised up and praised as a Universal Benefactor and Economic Sage of the First Order.

The problem with that argument is it fails to look at the poor baker and what he might have done with the $300 if his window had not broken. Maybe he would bought a new suit with that money. The tailor then might have bought a new sofa with his profits, and so on. The interconnectedness of the economy was not precipitated by the broken window. It was always there. The only thing that changed by the broken window is that the baker has no new suit, and the glazier has his money. Since you can never see the suit that was never made, it is easy to forget that the benefits to the glazier did not come from nothing.

So back to the IDC report, and this forecast of $70 billion dollars in Vista-related spending. The question to ask is, where is all this money coming from? And what might it have been used for if not spent on Vista-related purchases? Obviously this money was not created out of a vacuum. Is it coming from profits? From shareholders? From deferring other investments? Cutting back on training? Moving more jobs off-shore? Reducing quality? What companies and sectors of the economy are going to suffer for this shift in investment? What innovations will not occur because people are allocating resources to this upgrade?

In the end is $70 billion of new value really being produced? Or are we merely fixing broken Windows?

I don’t see anything fallacious in the IDC report. It’s a report on the (projected) localized effects within the U.S. IT industry, not the net effects to the entire economy. The report doesn’t claim that the $70b represents new wealth, only that it’s revenue for the local “ecosystem”. I think the job creation figures are intended to be understood in the same context.

If this were a report on Vista’s net economic effects then I think we could call this an example of the broken window fallacy.

Or, more in line with Hazlitt’s intentions, suppose this were a report advocating that the government spend $X billion for some project and that these will be the benefits. Now you’re talking broken window fallacy!

If you read the report in detail, you’ll see their claims go beyond your more modest retelling. For example, “Rapid and widespread adoption of Windows Vista means that its launch will not only affect Microsoft but will also have a pronounced positive impact on local economies throughout the world.”

That to me sounds like a much bolder claim.

In any case the fallacy is really about focusing entirely on the person fixing the broken window and the benefits that they receive without looking at who the losers are.

If a high altitude atomic burst had generated an EMP that wiped out $70 billion in hardware, we would consider this an enormous calamity and a blow to the economy. But Vista doing the same thing is a cause for celebration? You would think that the environmental damage alone of all that needlessly obsoleted and discarded hardware would give us pause.

“Rapid and widespread adoption of Windows Vista means that its launch will not only affect Microsoft but will also have a pronounced positive impact on local economies throughout the world.”

Yes, I agree that’s a more dubious claim. It would have to be justified in terms of the expected productivity gains and measured against the costs — not by tracing the exchange of currency through the economy and neglecting, as you say, that the money would otherwise be spent elsewhere.

In any case the fallacy is really about focusing entirely on the person fixing the broken window and the benefits that they receive without looking at who the losers are.

It’s also about the broken window — the Keynesian idea of stimulating the economy and somehow creating wealth by first destroying it. Hazlitt is not discussing private, free-market, non-criminal activity.

Hazlitt’s book is more generally about the common economic mistake of focusing on what is proximate, localized, and easily perceived — whether good or bad — while neglecting the effects that are more diffused harder to see.

The entire history of the computer industry has consisted of cycles of hardware and software upgrades (and at frequencies much higher than Vista’s five-year interval). If you’re pointing at the discarded hardware and software and suggesting that these cycles on net destroy wealth, then that would be, I think, an example of the broader fallacy.

You do not account for any benificial effect of technology upgrading. If there were no benifit to upgrading technology then why would people be buying it ?

People buy newer telephones because they provide new and better features. People buy newer cars because they are safer of more confortable or more fuel efficient. These spending also have extra spending effects that ripplie trough the economy.

Another point to make is that you use only one economic spending effect. The respending of the income. That only really relates to employees and dividend recipients of Microsoft spending the income further.However most of the economic effects of the Vista or MS Office upgrades are provided by combined spending where the investment in a new MS Office leads to extra related spending in hardware and services.

I think the real problem with how the IDC has described the Vista (economic) phenomenon relates to the words “pronounced positive”, as in …

“Rapid and widespread adoption of Windows Vista means that its launch will not only affect Microsoft but will also have a pronounced positive impact on local economies throughout the world.”

Anonymous said, “I see nothing fallacious in the parts quoted.”

The problem is that “pronounced” and “positive” have a normative aspect to them, which is debatable. Even the $70 billion figure says little, as Rob highlighted, because it’s $70b compared to what? $70b might be a shamefully low amount of economic value compared to alternatives.

It’s like standing in an isolation chamber and saying, “This bottle of milk costs $5. Is that expensive or cheap?” Impossible to answer in the abstract. The price/value has no meaning without looking at alternative products and vendors.

The spending on the usertraining that you use as an example is also likely to make your users more efficient as they can use a newer and better product. So the training combined with the newer software can create higher productivity for your organisation.

In economical terms it is an investment in your workforce that can create revenue by lowering the long term office costs.

One of the problems for a relative newcomer like OpenOffice is that organisations do not have the feeling that it will create a more efficient office environment so even the lower cost for licenses is not enough incentive for most organisations at the moment.

I have personally not found any independant studies into software efficiency and productivity for integrated office environments. In fact it is hard to find any [b]independant[/b] studies on any subject nowadays :(

The IDC report doesn’t deal with the job creation that might be engendered if if every $1 spent on a Vista licence was instead freed up to be invested or spent in higher job creation alternatives, such a leisure, internet, education etc, or simply saved for future spending by by using Linux/Open Office. These give much higher returns and employment for millions, not 159,000, returning perhaps $50 or more in newer wealths for every $1 spent. Where a licence is forced upon us where better of cheaper alternatives exist, it takes away choice.

The point about the baker’s broken window is the baker might simply have been able to claim on the insurance.

It’s a little harder to claim if instead of being broken by the errant baseball, the window was broken by a brick with a licence attached, and it was known in advance this was going to happen.

Some forms of Keynesianism do fall prey to the fallacy, especially military Keynesianism. But on the whole it’s not a good criticism. Keynes is saying that we (or the government) should pay for the window given that it is broken, not that we should break windows. It seems like the critics are saying that paying for a broken window means indulging in the fallacy. If we only stopped paying for them, we would stop incentivizing kids to “accidentally” break windows with baseballs.